In brief
Cryptocurrency custodians use a Proof of Reserves (PoR) audit process to show they hold all user funds. Binance conducts and publicly discloses internal audits, which are then verified by third-party auditors using cryptographic techniques to prove user funds are kept securely in its reserves. company. Binance users can also independently verify their account balances in these audits.
Introduce
Cryptographic proof supporting blockchain technology facilitates transparency in financial transactions of cryptocurrency exchanges. Proof of Reserves further increases this transparency by creating a delegated framework for vetting cryptocurrency custodians.
However, in the future PoR still needs improvements to make the ecosystem more transparent and trustworthy.
What is Proof of Reserve (PoR)?
A PoR audit is an audit that aims to ensure that the custodian is in full possession of their clients' funds. Custody businesses in the cryptocurrency sector use the PoR audit process to prove to depositors and the public that deposits match their balances. These audits are performed by independent third parties to eliminate the possibility of data reserves being falsified.
PoR is necessary for many reasons. First, it allows users to verify that the balance they hold on a cryptocurrency exchange, for example, is adequately backed by assets. Second, it pushes businesses to meet transparency standards, making it harder for them to engage in questionable or illegal financial activity.
Ideally, PoR will benefit both users and businesses. It protects users by minimizing security risks and fighting harmful players. At the same time, it helps businesses retain users by increasing their trustworthiness.
The ability to audit an exchange helps create a more transparent cryptocurrency ecosystem. For example, PoR prevents exchanges from acting as banks that lend deposited assets to third parties.
Likewise, exchanges cannot use deposits to invest in other protocols or businesses. In other words, PoR eliminates the risk of companies maximizing profits and other possible returns from holding customer assets.
With PoR, any entity can prove that a cryptocurrency exchange holds all user deposits. Therefore, exchanges are naturally incentivized not to abuse these balances, as that would break users' trust in them and affect their stability.
What does PoR verification include?
The PoR verification process involves the auditor verifying the balance of each account using cryptography. There are a few important steps to how this works.
First, the auditor takes a photo of the entire account balance. Then, convert the fund data into a Merkle tree, which is used to structure large amounts of data to make processing simpler.
The user's balance data is hashed into a "leaf". A group of these "leaves" is then hashed to form a "branch", and a group of "branches" are hashed to form a "root".
Next, auditors can use a variety of methods to verify ownership of user addresses. For example, on Binance, auditors have three ways to determine ownership. When this information extraction process is operated by the exchange, it is also verified by auditors.
Cryptographically signing messages: The auditor will provide the exchange with a separate message to cryptographically sign using their associated private key(s).
Guided transfers: The exchange is tasked with performing “guided transfers”, where the management will transfer a specific amount from a public key/address at a specific time and take transaction hash chain to verify transactions guided on the corresponding transaction blockchain.
Search for addresses on blockchain explorer: Testers can also search for ETH and BSC (in the case of Binance) address(es) on Etherscan and BscScan respectively to ensure that the addresses are mounted The card belongs to the exchange.
If the balance matches these forms of discovery, the exchange is considered to have verified the PoR and shows that it holds all of the deposited assets.
PoR: Limitations and potential for improvement
The balance of a cryptocurrency exchange changes as users move their assets in and out of the exchange. The problem with PoR is that it only verifies the accuracy of the reserve balance at the time the audit is assigned. This can be problematic because any problems may appear too late and the custodian may even use this opportunity to hide the truth.
It's also important to note that third-party businesses conduct the audits, meaning the audit results may depend on the qualifications of the individual auditors or whether they are influenced by outside interests.
But how can a cryptocurrency exchange improve its PoR testing to build and maintain user trust? It can start by shortening the time between audits to ensure there are no suspicious financial activities between cycles. An exchange may also use a reputable third-party company that has no financial interest in it or its related entities.
Cryptocurrency exchanges use PoR to provide more transparency, which is essential in times of financial turmoil. Because it uses mathematics and cryptography instead of just trust and communication like traditional banking systems, blockchain technology can provide an even better way to audit financial markets.
How to verify your account has been audited
You can also verify your Binance account yourself according to your most recent PoR check. Please follow the instructions below.
Log in to your Binance account and point to "Wallet". Next, select the "Test" tab.
You will see all recent checks where your account balance has been verified using the PoR process.
Select a specific audit about which you want more information. There you can also download the Merkle tree.
summary
You can access the PoR audit trail to see if the cryptocurrency custodian holds all of your and other users' coin reserves. The audits will prevent cryptocurrency exchanges from misusing user funds and help improve transparency in the cryptocurrency space.
PoR is the first step to regain and maintain the trust of cryptocurrency users. Furthermore, it places more demands on exchanges, which is expected to prioritize keeping user funds and make the entire industry more secure and transparent for all. .
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